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Tough week expected on stock markets as Fed tapers

On emerging market worries

TORONTO – Stock markets look set to extend a sell-off rooted in concerns about emerging markets and about corporate earnings deemed not quite good enough to extend last year’s powerful equity rally.

At the same, the focus will be on the Federal Reserve as traders look to see if the U.S. central bank will carry on with plans to continue to wind up its key stimulus program despite a weak jobs report for December.

“People are very bearish,” said John Stephenson, portfolio manager at First Asset Funds.

“No question, sentiment is overwhelming negative and (investors) are looking for a reason to sell.”

North American indexes fell sharply last week, with the TSX tumbling 1.23 per cent while New York’s Dow industrials fell 3.52 per cent.

Part of the reason was data showing that the Chinese manufacturing sector slipped into contraction territory in January.

But the Fed was the focal point of concerns that made investors step back amid worries about sharp drops in the value of currencies in several emerging markets, including Turkey, Russia, South Africa and Argentina.

These drops were sparked by moves by the Fed to cut back on its massive bond purchases, a key stimulus measure that fuelled a stock market rally and also kept long-term rates low. But U.S. bond yields have risen as the Fed moves to taper its purchases and investors have respondent by taking their money out of emerging markets.

This, in turn, has created anxiety about foreign exchange levels in these countries.

“And this all ties back to the Fed,” said Andrew Pyle, wealth adviser at ScotiaMcLeod in Peterborough, Ont.

“Because everyone believes the Fed is now tapering, (long-term) rates are going up in the U.S. and it’s causing a reverse of all that hot money flow that had gone into the emerging markets — now it’s going out and creating a problem,” Pyle said.

“It’s getting traction because analysts can see the impact on foreign exchange reserves. They look at the governments in these various countries and see a lack of leadership or management of this problem.”

The Fed decided in December to start cutting back on its monthly bond purchases by US$10 billion to $75 billion and the central bank is widely expected to further taper those asset purchases. Those purchases not only fuelled a strong rally on equity markets last year, they also have kept long-term rates low.

But U.S. bond yields have increased since last May, when the Fed first mooted the possibility of tapering, with the benchmark 10-year Treasury rising from about 1.6 per cent last April to about three per cent earlier this month. Yields have since backed off to about 2.75 per cent.

There doesn’t seem to be much doubt that the Fed will announce plans Wednesday to further cut back on asset purchases.

“I think they have to establish a program and I think the market expects that,” Pyle said.

He added these emerging market countries are paying the price for borrowing too heavily when long term-rates were lower.

The latest raft of fourth-quarter earnings reports in the U.S. haven’t done much for positive sentiment either.

It’s not that earnings and revenue have come in poorly. Pyle noted that beats on the revenue side are about 67 per cent (while) earnings were about 73 per cent in terms of beating expectations.

However, he observed that it’s not good enough to prevent a correction on U.S. markets that haven’t experienced a serious setback in about 18 months and while the S&P 500 index soared 30 per cent last year.

Meanwhile, quarterly earnings from Canadian companies pick up the pace this week. Among them, traders will take in earnings from grocer Metro (TSX:MRU) Canadian Pacific Railway (TSX:CP), PotashCorp (TSX:POT), and tech firm Celestica (TSX:CLS).

Investors will also digest the latest growth figures from Canada and the U.S. during the week.,

Statistics Canada is expected to report Friday that gross domestic product grew by 0.2 per cent in November amid rising manufacturing sales. That would be a slight dip from 0.3 per cent GDP growth in October.

Fierce winter weather is expected to have taken a toll on December GDP growth. But senior economist Peter Buchanan at CIBC World Markets said that “a 0.2 per cent rise in November, and comparable decline in the final month of the year, would leave fourth-quarter growth headed for a 2.7 per cent annualized increase.”

In the U.S., it is expected that data out Thursday will show fourth-quarter economic growth came in at an annualized pace of 3.2 per cent, following a 4.1 per cent rise in the previous quarter.

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